Beware the Economic Cleanup Crew

Published August 1, 2011

Fox Business

With the U.S. facing a recession, according to a growing chorus of economists, the government is getting set to launch a $150 billion stimulus plan. The debate now is whether the plan is loaded with gimmicks, acting as one congressman put it like a temporary vitamin B12 shot, or serious fiscal restructuring should take place. Here are some thoughts to consider:

1. The deficit hawks are getting trampled: Bernanke warned Congress in his testimony to exhibit fiscal discipline with tax cuts and spending, as he said the U.S. faces an explosive problem with the federal deficit. The costs for government spending, plus unfunded liabilities for Medicare and Social Security now easily amounts to four and a half times the size of the U.S. gross domestic product. That ought to make you spit your cornflakes across the room. And to say that the deficit doesn't matter is like saying ketchup is a vegetable or trees cause pollution. Taxpayers msut foot the bill for interest on all the treasury securities investors buy--among our biggest buyers is of course China ($2 trillion is held by foreign investors, China has about half that). On just the $9 trillion in debt for government spending alone, the amounts that are separate from Social Security and Medicare, the U.S. pays $405 billion in interest annually--well north of the GDP of Saudi Arabia or Belgium. Some argue that, well, a big chunk of that $9 trillion went toward hard assets like land, cars, trucks, bullion at Fort Knox, which can be liquidated if there's a problem. But as the housing crisis now proves, try unloading assets in a downturn--firesale prices prevail. The guardrails are totally off when it comes to how Congress now wants to blow out the deficit to save the economy with new fiscal stimulus plans. Watch this twist on Joseph Schumpeter, the economist famous for his line that the economy goes through creative destruction. When it comes to how it spends willy nilly our tax dollars, the government is about "all creation and no destruction." Rember this: It took the country from George Washington until Ronald Reagan to reach the first $1 trillion in debt.

2. Cut taxes: Honestly, I would just as soon listen to politicians trying to score points on the backs of a housing crisis as I'd listen to Evil Knievel's safe driving tips. Because politicians can fit what they know about economics up the left nostril of a very small bumble bee. Just witness their stubborn opposition to tax cuts, which has record federal revenues pouring in, has drained them of all common sense. We need a stable tax policy that is all about low rates. That's the best fiscal stimulus you can have now. It would put more money into taxpayers' pockets longer-term. Our unstable tax system is horribly unproductive and sucks a huge amount out of our economic growth. Hard as he tried to remain circumspect, Federal Reserve Chairman Ben Bernanke, whose purview is monetary not fiscal policy, did say an eye-brow raising comment. He said tax cuts "don't pay for themselves," sending fear into the hearts of Wall Streeters that the world's most powerful central banker gave cover to those who want to raise taxes, notably on capital gains and dividends. A debate worth having, whether tax cuts add to federal revenues or whether inflation, population growth, and just long-run economic growth do. What the tax hikers ignore is that tax cuts do unlock economic growth--capital gains taxes, for instance, are voluntarily paid. Taxpayers often hold off on selling an asset, like a house, so they can pay at the lower long-term capital gains rate. Cut capital gains taxes and you unlock that asset--raising capital gains will help keep the housing market iced over, frozen solid, as no one will sell.

3. Consider a flat tax: Ok, I confess, I am a flat-taxer, having covered the IRS for about a decade and having testified before Congress about IRS abuses of taxpayers (a weird position for a journalist to be put in, for sure, so I based my testimony on a government report about the agency). I saw first-hand how “America's museum of mass confusion” as the Heritage Foundation rightfully calls it, severely abused taxpayers. A flat tax would ignite the economy, would bring in record revenues, and it would detonate the IRS as well as the Gucci Gulch, still thriving (it's no wonder that the tax writing committees get the most visits from lobbyists as well as the most political donations.Just witness the back story to Europe's 2.7% GDP growth last year. Yes that sounds teeny tiny, but hey they broke out the hats and horns over there in the land of the welfare state. Europe's GDP growth is due to the adoption of a flat tax in former Soviet satellite states, now part of Eastern Europe. Russia passed the flat tax in 2001, and immediately revenue jumped 26% in the first year, says SageWorks, a financial advisory and research house in Triangle Park, N.C. Estonia went to a flat tax in 1994, and from 1997 to 2005 saw an annual GDP growth of 6%. Lithuania implemented the flat tax a year later, in 1995. Tax revenues grew substantially and Lithuania saw an average GDP growth rate of 7% for the next five years. Latvia passed a flat tax in 1997 and saw GDP grow 11% over five years while government revenues rose 13%. Ironic, isn't it, because a flat tax runs contrary to the ideals of Marxism, “from each according to his ability, to each according to his needs,” Karl Marx once said about the progressive tax system. So the first former communist nations to implement the flat tax are now the richest of the group.

4. Cut corporate taxes: Companies don't pay taxes—instead, customers, investors and employees do. In fact, a growing chorus of academics are saying it's likely workers who actually get it in the neck first from high corporate taxes—evidence for why wage growth has stagnated. Another piece of info: although Iceland does not have a pure flat tax, when it lowered corporate taxes, corporate tax revenues increased. Same for, get this, Egypt. Rudy Giuliani, now running for the Republican presidential nomination, has this one right. So does Treasury Secretary Henry Paulson. Today the United States' corporate tax rate ranks among the highest among the 30 nations in the Organisation of Economic Cooperation and Development (OECD), a Paris-based group which encompasses the world's industrialized nations. "We now have, on average, the second-highest statutory corporate tax rate (including state corporate taxes), 39 percent, compared with an average rate of 31 percent for our top competitors," Paulson says. "A study by Treasury economists estimated that a country with a tax rate one percentage point lower than another country's attracts 3 percent more capital."

Ok those are my thoughts on fiscal stimulus. Now on to cleaning up Wall Street's housing mess.